“No industry has a comparable talent
for privatising gains and socialising losses. Participants
in no other industry get as self-righteously angry when
public officials – particularly central bankers – fail
to come at once to their rescue when they get in to (well
deserved) trouble.”

He goes on to
say……

“These are the only businesses able to
devastate entire economies…….I now fear that the
combination of the fragility of the financial system with
the huge rewards it generates for insiders will destroy
something more important –the political legitimacy of the
market economy itself – across the globe. So it is time to
start thinking radical thoughts about how to fix the
problems.”

“The big points here are that,
first, we cannot pretend that the way the financial system
behaves is not a matter of public interest……and second,
if the problem is to be fixed, incentives for decision
makers have to be better aligned with the
outcomes”.

“Even so, most readers would suspect
something is not right here. Indeed compensation practices
in the financial sector are deeply flawed and probably
contributed to the ongoing crisis”.

Mr Rajan
describes the ability to create wealth as “alpha”
-

“A venture capitalist who transforms an inventor, a
garage and an idea in to a fully fledged, profitable and
professionally managed corporation creates alpha…..A third
source of alpha is financial entrepreneurship or engineering
– creating securities or cash flow streams that appeal to
particular investors or tastes. As long as the investment
manager does not create securities that exploit investor
weaknesses or ignorance (and there is unfortunately too much
of that), this sort of alpha is also beneficial, but it
requires constant innovation”.

The reality is that
“true alpha” –in the sense of the ability to innovate,
solve problems and manage the processes involved in creating
wealth – is a rarity. Very few have this ability. Mr Rajan
explains how instead people within the finance sector (and
it occurs elsewhere too) have to date been paid excessively
for “fake alpha” – where there has been the appearance
of excess returns, but in reality the “tail end risks”
have been ignored or hidden. Essentially – selling
“toxic rubbish” as top quality and secure investment
product.

Understandably – with these “incentives”–
the finance sector has been a huge supporter of urban
property inflation, oblivious to the great harm being
inflicted on often the most vulnerable in the community,
“flogging” excessive and poorly structured mortgage and
consumer debt. The Marketing Departments of these
organisations (sometimes referred to as the Economic
Departments) have even gone to the extent of referring to
urban “inflation” as “growth” as I outline in my
recent article Scoop: Housing Affordability – The Shift
To Reality .

The extent of the “urban inflation”
of the 227 major urban markets of the Anglo world (USA,
Canada, United Kingdom, Ireland, Australia and New Zealand)
will be illustrated in the 2008 4th Edition Demographia
International Housing Affordability Survey, due for
release midnight Sunday 20
January.

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